For all the sudden pessimism about India's economy, Kaushik Basu sleeps soundly at night - and if something was going to keep him awake it wouldn't be the risk of a balance of payments crisis.

Out of tune with a chorus of gloom, India's chief economic adviser believes the tide has turned in a long battle against inflation and the economy is set to rebound to its "full-steam" growth rate of around 9 percent within two years.

"I believe it is time to focus on growth because inflation is in its last stages," Basu told Reuters in an interview from his finance ministry office in New Delhi, where closed-door preparations are now underway for the 2012/13 budget.

Basu said that economic growth has faltered in fiscal 2011/12 and will end the year on March 31 at around 7.5 percent, far lower than the 9 percent forecast in last year's budget, which has since been pilloried for being so optimistic.

That slowdown was due to a combination of feeble growth in the United States and Europe, a ratcheting up of interest rates to quash inflation that has run at over 9 percent for a year and a decision-making paralysis in government.

Basu said the United States was now on a "slow rise", Europe looked set to avoid another recession and monetary tightening has run its course as inflation heads lower, with the headline rate set to drop to 6.75 percent as early as March.

"If these expectations are right, then I think India has enough fundamental strength that we will get out of the current slowdown and begin to move," he said.


However, he had little hope to offer on the political and bureaucratic constraints on economic growth, noting that policy makers are avoiding taking risks because of a climate of fear after a spate of corruption scandals.

"Given the corruption scandals last year and also some mindless finger-pointing that is going on, we are going through a phase of excessive risk aversion," he said.

Manmohan Singh, architect of the reforms that transformed India's state-stifled economy in 1991, has taken few steps to open the economy up further since he took over as prime minister in 2004. Critics say his government is now mired in a policy paralysis.

Plans to throw open the country's $450 billion retail sector to global supermarket players were dashed by political opposition last month.

That dented investor confidence in an economy that appeared to be losing steam after averaging growth of nearly 10 percent for three years before the 2008 financial crisis, and helped knock the rupee currency to an all-time low.

Basu said growth in the third quarter of 2011/12 would come in below 6.9 percent because industrial output was weak even though services and agriculture held up. However, he expects a rebound in the January-March quarter to above 7.5 percent.

Early signs of that recovery came this week with purchasing managers data showing that manufacturing activity surged to a six-month high in December thanks to a spike in factory orders and new orders from domestic and international firms.

However, HSBC said in a research note on Wednesday that it was too early to conclude that the growth wobble was over.

"The pace of growth still remains below its historical average," it said. "Moreover, there is no denying that tight monetary policy, domestic policy paralysis and adverse external spill-overs will constrain growth in the months ahead."


Sluggish tax receipts due to the economic slowdown and high expenditure on subsidies have sparked concerns that the fiscal deficit could miss the budgeted target of 4.6 percent of GDP by almost one percentage point in the current fiscal year.

The cash-strapped government said last week it would borrow an additional 400 billion rupees) through bonds in 2011/12. This comes on top of an increase in the borrowing target for the second half of the fiscal year to 2.2 trillion rupees from an originally budgeted 1.67 trillion.

Basu said 2012/13 would be a "very difficult" year for public finances, but he reiterated the government's commitment to fiscal consolidation.

"The deficit (next year) will be lower than this year. We are determined about that," he said, adding that the government would borrow less in 2012/13 to leave room in the market for an expected pick-up in private borrowing.

A slowdown in exports has also blown out the country's current account deficit beyond the government's perceived comfort level of 3 percent of GDP.

Citi said in a report on Wednesday that it saw the deficit widening to 3.5 percent in 2011/12 and further to 3.6 percent the following fiscal year, gaps that would require capital inflows equivalent to twice the amount India received last year.

Basu was sanguine, however, predicting that growth in manufacturing exports will reduce the deficit from next year.

"While our exports have slowed down over the last two months and the current account deficit has widened, I see no reason to worry about the overall balance of payments situation," he said. "If I am keen on losing sleep I can find better candidates."

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